Edited version of your private ruling

Authorisation Number: 1012585277867

Ruling

Subject: Related Schemes

Question 1

Will the Commissioner make a determination under subsection 974-15(4) of the Income Tax Assessment Act 1997 that it would be unreasonable to treat the schemes as a related scheme giving rise to a debt interest under subsection 974-15(2) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

If the response to Question 1 is yes, will the Ordinary Shares be a scheme that gives rise to an equity interest pursuant to paragraph 974-70(1)(a) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 3

If the response to Question 1 is yes, will the Redeemable Preference Shares be a scheme that gives rise to a debt interest pursuant to subsection 974-15(1) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 4

If the response to Question 1 is yes, will the Loans be schemes that give rise to debt interests pursuant to subsection 974-15(1) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 2014

Income year ending 30 June 2015

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018

Income year ending 30 June 2019

Income year ending 30 June 2020

Income year ending 30 June 2021

Income year ending 30 June 2022

Income year ending 30 June 2023

Income year ending 30 June 2024

The scheme commences on:

During the income year ended 30 June 2014

Relevant facts and circumstances

Taxpayer Co is an Australian resident company.

Funding for Taxpayer comprises of:

· fully paid ordinary shares (OS) issued to Lender Co

· fully paid redeemable preference shares (RPS) issued to Lender Co

· interest free loans (the Loans) from Lender Co

The ordinary shares, RPS and/or the Loans are not stapled.

Taxpayer Co Ordinary Shares

The terms and conditions of the issue of OS are governed by the Taxpayer Co constitution (the Constitution).

Pursuant to the Constitution, the directors of Taxpayer Co may issue and cancel shares in Taxpayer Co.

Each OS confers the:

· right to receive dividends. Under the Constitution, the directors of Taxpayer Co have an absolute discretion to declare or determine that a dividend is payable, fix the amount and time for payment of the dividend

· right to vote at any meeting of shareholders on the basis of one vote per fully paid OS

· right to share in any surplus capital on a winding-up

· right to participate in a general meeting to appoint directors of the company

Taxpayer Co Redeemable Preference Shares

Pursuant to the Constitution, a RPS is a separate class of shares in Taxpayer Co, with a face value equal to the Issue Price and carrying the rights, powers, privileges and obligations referred to in the Constitution.

Each RPS confers the right to a dividend payable in accordance with the Constitution.

The directors of Taxpayer Co may in their absolute discretion determine whether to pay dividends on the RPS for a financial year. If the directors determine that no dividend is payable, a RPS shareholder has no entitlement to receive any dividend in respect of the financial year.

Pursuant to the Constitution, Taxpayer Co must redeem the RPS for the redemption amount on the redemption date. The redemption date is the date that is one business day prior to the 10^th anniversary of the earliest issue date for any RPS issued by Taxpayer Co. The redemption amount is a fixed amount that is higher than the issue price of the RPS.

The RPS rank equally amongst themselves but in priority to OS on a return of capital.

If there is a return of capital on a winding-up of Taxpayer Co, a RPS confers the right to receive the Redemption Amount out of the assets of Taxpayer Co available for distribution before any return of capital is made to OS shareholders or any other class of shares ranking behind RPS.

A RPS does not confer any right to vote at a general meeting of Taxpayer Co, other than for the circumstances specified in the Constitution, which includes reducing Taxpayer Co's preference share capital, approving terms of a buy-back agreement to buy back or cancel RPS, a proposal that affects the terms of the RPS, to wind up the company, and disposal of the company's property, business and undertaking or during winding up of Taxpayer Co.

There are no restrictions on the transfer of a RPS.

The Loans

The terms and conditions of the Loans are contained in the Loan Agreements. The term of the Loan is a period less than 10 years.

Interest is not and will not be payable on the Loans.

Taxpayer Co must repay the principal outstanding on the earlier of demand by Lender Co and the repayment date, unless, in the case of a particular loan, earlier converted to OS.

No fees or other borrowing costs in relation to the Loans are payable by Taxpayer Co under the Loan Agreements.

Pursuant to the Loan Agreements a particular loan, in full or in part, is convertible into OS solely at the request of Lender Co. Broadly, conversion is defined as the repayment of the principal outstanding (or part thereof) and the application of the proceeds to subscribe for OS in Taxpayer Co. At any time prior to the repayment date of the particular loan, Lender Co may give Taxpayer Co a conversion notice stating that the conversion will occur and specifying the amount of Principal Outstanding that will convert to OS and the date on which the conversion will occur.

The lender does not anticipate it will assign the Loans to any other party.

The OS, RPS, and the Loans together are a related scheme pursuant to section 974-155 giving rise to a notional scheme that is a debt interest in Taxpayer Co pursuant to subsection 974-15(2).

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 Subdivision 974-B

Income Tax Assessment Act 1997 subsection 974-5(4)

Income Tax Assessment Act 1997 subsection 974-10(1)

Income Tax Assessment Act 1997 subsection 974-10(2)

Income Tax Assessment Act 1997 subsection 974-10(3)

Income Tax Assessment Act 1997 section 974-15

Income Tax Assessment Act 1997 subsection 974-15(1)

Income Tax Assessment Act 1997 subsection 974-15(2)

Income Tax Assessment Act 1997 subsection 974-15(4)

Income Tax Assessment Act 1997 subsection 974-15(5)

Income Tax Assessment Act 1997 subsection 974-20(1)

Income Tax Assessment Act 1997 paragraph 974-20(1)(a)

Income Tax Assessment Act 1997 paragraph 974-20(1)(b)

Income Tax Assessment Act 1997 paragraph 974-20(1)(c)

Income Tax Assessment Act 1997 paragraph 974-20(1)(d)

Income Tax Assessment Act 1997 paragraph 974-20(1)(e)

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 subsection 974-70(1)

Income Tax Assessment Act 1997 paragraph 974-70(1)(a)

Income Tax Assessment Act 1997 paragraph 974-70(1)(b)

Income Tax Assessment Act 1997 subsection 974-75(1)

Income Tax Assessment Act 1997 paragraph 974-75(1)(a)

Income Tax Assessment Act 1997 subsection 974-75(2)

Income Tax Assessment Act 1997 subsection 974-75(3)

Income Tax Assessment Act 1997 subsection 974-135(4)

Income Tax Assessment Act 1997 section 974-112

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997

Question 1

Summary

The Commissioner will make a determination under subsection 974-15(4) that it would be unreasonable to treat the schemes as a related scheme giving rise to a debt interest by application of subsection 974-15(2). That will be a determination by the Commissioner that is covered by section 974-112.

Detailed reasoning

Two or more related schemes do not together give rise to a debt interest under subsection 974-15(2) if the Commissioner determines that it would be unreasonable to apply that subsection to those schemes (subsection 974-15(4)).

The Commissioner must have regard to the objects stated in subsections 974-10(1)-(3) in exercising the power to make a determination under subsection 974-15(4) (subsection 974-10(5). In particular, the Commissioner must, in exercising the power to make a determination under subsection 974-15(4), have regard to:

(a) the purpose of the schemes (considered both individually and in combination);

(b) the effects of the schemes (considered both individually and in combination);

(c) the rights and obligations of the parties to the schemes (considered both individually and in combination);

(d) whether the schemes (when considered either individually or in combination) provide the basis for, or underpin, an interest issued to investors with the expectation that the interest can be assigned to other investors;

(e) whether the schemes (when considered either individually or in combination) comprise a set of rights and obligations issued to investors with the expectation that it can be assigned to other investors;

(f) any other relevant circumstances.

Considered individually the purpose of the OS is to:

· to raise equity finance for Taxpayer Co

· bear all residual risks

· enable the payment of after tax profits as franked dividends

· provide owners with rights to vote, appoint directors and receive dividends.

Considered individually the purpose of the RPS is to provide a commercial debt interest in Taxpayer Co that provides for:

· limited voting rights

· no eligibility to share in any surplus on winding-up

· discretionary dividend payments giving Taxpayer Co flexibility to repatriate profits/surplus cash

· return of investment capital upon redemption

Considered individually the purpose of the Loans is to provide a commercial debt interest in Taxpayer Co.

Having regard to the operation of the schemes in combination, the objectives of the individual schemes are achieved. Commercially, this may not occur if Taxpayer Co were financed solely by debt or by equity. Accordingly, it is reasonable to conclude that the purpose of implementing the schemes in combination was not different to the schemes when considered individually.

The individual effect of the issue of the OS was to create an equity interest in Taxpayer Co. The individual effect of the issue of the RPS was to create a debt interest in Taxpayer Co. The individual effect of the Loans was to create a debt interest in Taxpayer Co. When considered in combination, the economic effect of the notional scheme is to raise finance.

The OS carry rights and obligations normally associated with an OS investment. They provide OS shareholders with the risks and benefits associated with ordinary equity instruments (bearing residual risks of the company, voting rights and dividend entitlements contingent on economic performance and the exercise of the director's discretion).

On an individual basis, the lenders of the Loans and the holders of the RPS have the rights and obligations of unsecured lenders, and Taxpayer Co has the rights and obligations of an issuer of an unsecured debt instrument. The holders of the OS and Taxpayer Co have the rights and obligations that would normally be associated with an ordinary share investment. That the result of treating the schemes as not related may be advantageous to Taxpayer Co in the sense of facilitating the particular key commercial objectives/drivers advised for entering into the schemes is neutral because it is no more than the result of debt and equity schemes being treated differently. Relevantly if the notional scheme characterisation was maintained Taxpayer Co would be rendered without any equity for tax purposes. Taxpayer Co has no other OS on issue. Any after tax profits of Taxpayer Co could not be distributed as frankable dividends. This could lead to an unwarranted accumulation of franking credits in the company.

As a matter of commercial reality, the schemes are not stapled, can be dealt with separately according to the legal rights and obligations of the schemes and may allow for third parties to invest in Taxpayer Co. On the facts, there is no positive evidence that points to an intention to circumvent the debt and equity tests by entities entering into a number of separate schemes instead of a single scheme. The accounting and commercial reasons advised by Taxpayer Co surrounding the schemes support its stated intention in undertaking the funding structure and are considered to support the making of a determination under subsection 974-15(4).

In view of the totality of the above factors, none of which alone is conclusive, the Commissioner will make a determination under subsection 974-15(4) that it would be unreasonable to apply subsection 974-15(2) to the related schemes. Accordingly, the Commissioner will not treat the related schemes (the OS, RPS and the Loans) as together giving rise to a notional debt interest in Taxpayer Co.

Question 2

Summary

The OS are a scheme that gives rise to an equity interest in Taxpayer Co pursuant to paragraph 974-70(1)(a).

Detailed reasoning

Division 974 establishes a test for determining whether a scheme gives rise to a debt interest or an equity interest in an entity for particular income tax purposes.

Subsection 974-70(1) provides that a scheme gives rise to an equity interest in a company if, when the scheme comes into existence:

(a) the scheme satisfies the equity test in subsection 974-75(1) in relation to the company because of the existence of an interest; and

(b) the interest is not characterised as, and does not form part of a larger interest that is characterised as, a debt interest in the company or a connected entity of the company under Subdivision 974-B.

A scheme satisfies the equity test in relation to a company if it gives rise to one of the interests set out in the table in subsection 974-75(1).

The issue of OS by Taxpayer Co is a scheme as defined in subsection 995-1(1).

An OS in Taxpayer Co is an interest in the company as a member of the company (item 1 of the table in subsection 974-75(1)). Therefore the condition in paragraph 974-75(1)(a) is satisfied.

Subsections 974-75(2) and 974-75(3) do not apply to the OS because the scheme satisfies item 1 of the table in subsection 974-75(1).

Pursuant to paragraph 974-70(1)(b), a scheme does not give rise to an equity interest in a company if the scheme is characterised as a debt interest in the company under Subdivision 974-B.

Subdivision 974-B provides the test for determining when a scheme gives rise to a debt interest in an entity. A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity.

A scheme satisfies the debt test in subsection 974-20(1) in relation to an entity only if all the conditions in subsection 974-20(1) are met. Taxpayer Co does not have an effectively non contingent obligation under the OS scheme to provide a financial benefit or benefits to one or more entities after the time when the financial benefit or benefits is received. The right to receive a dividend in relation to an OS is contingent on the economic performance of Taxpayer Co. Similarly, the right to a distribution of surplus capital on the winding-up of Taxpayer Co is contingent on such event happening. As Taxpayer Co does not have an effectively non contingent obligation to provide financial benefits under the OS, the condition in paragraph 974-20(1)(c) is not met and the scheme does not satisfy the debt test in subsection 974-20(1) in relation to Taxpayer Co. Accordingly the OS do not give rise to a debt interest under Subdivision 974-B.

As the conditions in subsection 974-70(1) are satisfied and the debt test is not satisfied, the OS are a scheme that gives rise to an equity interest in Taxpayer Co under section 974-70.

Question 3

Summary

The RPS is a scheme that gives rise to a debt interest in Taxpayer Co pursuant to subsection 974-15(1).

Detailed reasoning

Division 974 establishes a test for determining whether a scheme gives rise to a debt interest or an equity interest in an entity for particular income tax purposes.

If an interest could be satisfy both the debt test and the equity test it is treated as a debt interest and not an equity interest (subsection 974-5(4)). Accordingly it is not necessary to apply the equity test if the debt test has been satisfied. That is, the issue of RPS in Taxpayer Co does not give rise to an equity interest if the RPS are characterised as a debt interest in Taxpayer Co under Subdivision 974-B.

The issue of RPS is a scheme as defined in subsection 995-1(1) which came into existence when the RPS issued. Subdivision 974-B provides the test for determining when a scheme gives rise to a debt interest in an entity. A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity.

The debt test in subsection 974-20(1) is satisfied in relation to an entity if:

· the scheme is a financing arrangement: paragraph 974-20(1)(a)

· the entity or a connected entity receives or will receive a financial benefit or benefits under the scheme: paragraph 974-20(1)(b)

· the entity has, or the entity and a connected entity of the entity each has, an effectively non contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when the financial benefit (or first of the financial benefits if more than one) is received: paragraph 974-20(1)(c)

· it is substantially more likely than not that the value of the financial benefits provided will be at least equal to the value if the financial benefits received: paragraph 974-20(1)(d), and

· the value provided and the value received are not both nil: paragraph 974-20(1)(e).

The requirement in paragraph 974-20(1)(a) does not need to be satisfied because Taxpayer Co is a company and the RPS are an interest covered by item 1 of the table in subsection 974-75(1) (subsection 974-20(1)).

Taxpayer Co receives a financial benefit under the scheme, being the amount of the issue price received for each RPS issued.

Taxpayer Co has an effectively non contingent obligation to provide a financial benefit under the scheme because the RPS must be redeemed for the redemption amount on the redemption date.

The RPS must be redeemed at a premium. Accordingly, the value of the financial benefit to be provided by Taxpayer Co will exceed the value of the financial benefit received by Taxpayer Co. Accordingly the requirements in paragraphs 974-20(1)(d) and 974-20(1)(e) are satisfied.

As the requirements of subsection 974-20(1) are met, the RPS satisfy the debt test in subsection 974-20(1) and the issue of RPS is a scheme that gives rise to a debt interest in Taxpayer Co under Subdivision 974-B. Therefore, the RPS in Taxpayer Co are characterised as a debt interest under subsection 974-15(1) and do not give rise to an equity interest.

Question 4

Summary

The Loans are schemes that give rise to debt interests in Taxpayer Co pursuant to subsection 974-15(1).

Detailed reasoning

Division 974 establishes a test for determining whether a scheme gives rise to a debt interest or gives rise to an equity interest in an entity for particular income tax purposes.

If an interest could be satisfy both the debt test and the equity test it is treated as a debt interest and not an equity interest (subsection 974-5(4)). Accordingly it is not necessary to apply the equity test if the debt test has been satisfied. That is, the Loans do not give rise to an equity interest in Taxpayer Co if they are characterised giving rise to debt interests in Taxpayer Co under Subdivision 974-B.

The Loans are schemes as defined in subsection 995-1(1). Subdivision 974-B provides the test for determining when an interest is a debt interest in an entity. A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity.

The debt test in subsection 974-20(1) is satisfied in relation to an entity if:

· the scheme is a financing arrangement: paragraph 974-20(1)(a)

· the entity or a connected entity receives or will receive a financial benefit or benefits under the scheme: paragraph 974-20(1)(b)

· the entity has, or the entity and a connected entity of the entity each has, an effectively non contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when the financial benefit (or first of the financial benefits if more than one) is received: paragraph 974-20(1)(c)

· it is substantially more likely than not that the value of the financial benefits provided will be at least equal to the value of the financial benefits received: paragraph 974-20(1)(d), and

· the value provided and the value received are not both nil: paragraph 974-20(1)(e).

The Loans are financing arrangements as defined in section 974-130 because they raise finance for Taxpayer Co.

Taxpayer Co receives a financial benefit under the scheme, being the amount borrowed under the Loan.

The repayment of the loan principal is a requirement of the Loan Agreement and is not contingent on the availability of profits or cash. That Taxpayer Co may not be able to pay monies to the Lender when required does not prevent there being an effectively non-contingent obligation (subsection 974-135(3)). A particular loan is convertible to OS at the option of Lender Co, and must occur at market value. The financial benefit is the face value of the Loans. Taxpayer Co has the effectively non-contingent obligation to provide that financial benefit because, when regard is given to the pricing, terms and conditions of the Loans, Taxpayer Co has an obligation, in both substance and effect, to repay the Loans. The conversion to OS option of the lender does not of itself make Taxpayer Co's obligation to repay the particular loan contingent (subsection 974-135(4)).

Taxpayer Co must repay the full amount of the Loans on the repayment date unless repaid earlier or converted into OS at the Lender's election. Accordingly, the value of the financial benefit provided by Taxpayer Co will at least equal the value of the financial benefit received by Taxpayer Co and the value provided and the value received are not both nil.

Accordingly, the Loans satisfy the debt test in subsection 974-20(1) and give rise to debt interests in Taxpayer Co under Subdivision 974-B.

As the Loans satisfy the debt test under Subdivision 974-B, they do not meet the requirement in paragraph 974-70(1)(b) and do not give rise to an equity interest in Taxpayer Co.